Markets, Fed Still at Odds Over Outlook for Economy

The U.S. Federal Reserve and financial markets seem to be sharply at odds over where theeconomy and interest rates are heading, and fresh Fed forecasts to be released Tuesday are unlikely to bridge that gap.

Fed policy-makers have indicated they expect the economy to claw its way back to relative health at some point next year, and that the current setting of interest rates is likely wellpositioned to help it to do so.

Kathy Willens

Traders at SIG Specialists trading post on the floor of the New York Stock Exchange talk among themselves shortly after the opening bell Monday, April 18, 2005, in New York. Stocks regained some stability Monday following a three-day selloff as strong first-quarter earnings and a pair of merger announcements lent some support to a market battered by worries about economic growth. (AP Photo/Kathy Willens)

More detailed and extensive forecasts to be released by the U.S. central bank Tuesday are likely to underscore that view.

But many financial market participants and some top economists expect the persistent housing slump, cooler spending and continued turmoil in financial markets to weigh more heavily on the economy, perhaps even triggering a recession.

"Confirm the Divergences"

"The new forecasts will not converge but rather confirm the divergences that there are between the markets and the Fed," said Michael Feroli, economist at JPMorgan in New York.

Prices for U.S. government debt rose in a safe-haven bid on Monday as stocks fell on creditconcerns and traders raised bets on interest-rate cuts.

Since mid-September, the Fed has lowered the benchmark federal funds rate by a cumulative three-quarters of a percentage point to prevent economic fallout from financial turmoil sparked by losses in the U.S. subprime mortgage market.

The target for overnight rates now stands at 4.5 percent.

Futures markets have moved to price in a near certainty of another quarter-point reduction at the next Fed meeting on Dec. 11, a 64 percent implied chance of a cut to 4 percent inJanuary, and about a 28 percent chance of a cut to 3.75 percent in March.

Harvard University professor Martin Feldstein, who said in late August the Fed would have to ease by a full percentage point, said Monday the central bank would have to lower rates by at least another quarter-point in December and more next year to stave off a recession.

"Fed Has to Move"

"The Fed has to move the federal funds rate to some number beginning with 3, not 4," he said at the Council on Foreign Relations, adding that downside economic risks were larger nowthan they had appeared in August.

Wall Street also has been reassessing its view, and appears to be moving further away from the Fed, not closer to it.

AP

"We can easily imagine having to make room for more rate cuts than we are currently forecasting if the news on the economy and the markets stays as troubling as it has beenlately," Goldman Sachs economists said in a recent research note. Goldman currently expects the federal funds rate to reach 4 percent by the end of the first quarter.

In unusually direct comments Friday, Fed Governor Randall Kroszner said more rate cuts did not appear warranted, even though growth looked set to weaken in the near term.

"The current stance of monetary policy should help the economy get through the rough patch during the next year, with growth then likely to return to its longer-run sustainable rate," he said.

Other policy-makers have offered a similar, if less direct, message, with little impact on market expectations.

Changing Rate Forecast

JPMorgan changed its Fed call late last week, saying it now expected a quarter-percentage point cut in both December and January due to growing downside risks to the economy. It hadpreviously thought the Fed would be on hold at both meetings.

Allan Meltzer, a professor at Carnegie Mellon University, said the markets had forced the Fed's hand to lower rates last month and it appeared they would do so again in December.

"As the market has priced in a cut, the Fed is where it was" before its last meeting, he said, speaking at the Council on Foreign Relations with Feldstein.

High oil prices, which have hovered below $100 a barrel, would dampen consumer spending but the Fed could do little about that directly, he said, adding that he thought the economy would avoid recession nevertheless.

On Tuesday, the Fed will have another chance to bring markets closer to its view. Along with minutes of its last rate meeting on Oct. 30-31, it will release updated forecasts fromFed policy-makers.

In the past, the central bank released such forecasts twice a year, but Tuesday it will begin releasing them quarterly and in an expanded format that will provide more detail on howofficials view the outlook.

To view this site, you need to have JavaScript enabled in your browser, and either the Flash Plugin or an HTML5-Video enabled browser. Download the latest Flash player and try again.